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Tuesday, January 3, 2012

Tuesday, January 3, 2012

Higher Ed in 2012: Background Thoughts on the Public Sector Under Subsidized Capitalism

Assuming that hope springs eternal in education like everywhere else, what can public university faculty and staff hope for in 2012?

This is a long post about the public university and a fundamental problem with American economic practice. I've written it as part of a conversation that needs to be much more dynamic and widespread about the value of public, government-based investment in things like health, infrastructure, education and research.  For a while now I have felt real urgency about this.  If the US can't get over the hump and start spending real money through public institutions on social needs, our distored, inefficient private sector is going to keep suffocating public universities, not to mention the public and the economy overall.  The Occupy movement made millions of people feel like they could do something about a private sector that has stopped working for the vast majority of society.  My thoughts here are about how universities should react.

As we start 2012, neither the economy nor the political system promise improvement. The relationship between these two dimensions of U.S. society seems as benighted as it has ever been.  The presidential campaign is a perfect example, where the leading Republican candidate, the Harvard-educated investment banker Mitt Romney, routinely defines government as what takes things away from people, and his "opportunity nation" as negating government with liberty.  As of this writing, bookmakers are giving this guy a one in three chance of being the next president.

Our backward, benighted political discourse about collective action in general and public investment in particular has effects large and small.   On the state level, politicians have been brutally squeezing anything like childhood health or schooling or whatever else looks like an investment in the collective future.   To take the obvious example, the University of California has lost about one-quarter of its state funding in the past year alone (e.g. Display 1).

We are often asked to pin this irrational destructiveness on Congress or on the Sacramento legislature, which in the latter case means blaming rabidly anti-tax Republican minorities and their lock-step Grover Norquist no-tax pledging.  But 2011 was the year in which Democrats stepped up to budget cutting on a Republican scale.  California Democrat governor Jerry Brown's higher ed cuts were as large as those of his Republican predecessor, and havoc has been created in the state of Washington's public ed sector in large part by a Democratic governor there.

We are confronting the "end of growth in the United States," the real possibility of two "zero decades" in a row, the looming death of the middle class, and a population that is nearly half poor or near-poor.   And yet 2011 saw the cementing of a bipartisan consensus in the US and Europe against expanding public investment. This blog opposed Hooverite austerity when it was Arnoldonomics and we oppose it even more today, but this means we are now forced into full opposition to the party that has traditionally supported a counter-cyclical public sector to correct market expansion, but that no longer does.

This brings us to the deeper question of why are the Democrats so terrible on stimulus and development issues, so easily talked out of even ordinary support for them?

I. Theory Failure
The easy answer is that like the Republicans, the Democrats are bought and controlled by the finance industry.  Finance has indeed successfully persuaded the political class to transform huge amounts of private debt and bad assets into public debt.  This process of creating a gigantic overhang of sovereign debt to help banks continues to destabliize Europe and has slowed if not blocked recovery in the U.S. Governments are now more likely to fail than are zombie banks, for the simple reason that "markets" will punish with very high borrowing costs any government that show an interest in forcing private parties to share loses on bad bets.  One recent book calls this the endgame to our "debt supercycle" in which the most likely outcome is depression spreading in the face of governments deprived of the resources to invest in their own people as either producers or consumers.  The housing and banking crises, coupled with continued bulk purchases by banks of political influence, have finally managed to take out even the residual Keynesianism that offered some counter-cyclical pressure in the form of the Obama stimulus of 2009.

The deeper answer to the question of Democrat weakness is that they have no theory of public investment that would allow them to act differently from Republicans. This would require them to resist the sociopathic special pleading of banking heads, heed the mainstream moderate Keynesianism of Nobel prizewinners like Paul Krugman and Joseph Stiglitz, present to their constituents a national development agenda,  and rally popular support for a major rebuilding effort led by government as both coordinator and investor.  2011 showed that Democrats are as unable to command any of this as Republicans, with President Obama as unCommander-in-Chief.  The reason is that Obama, like the rest of the party, associates economic development entirely with the private sector.  "Our free enterprise system is what drives innovation," Obama said in his State of the Union Address last year.  The government's role is to give early-stage money to the private sector, and go away.

Our more local symptom of the Democrats' mental paralysis is Governor Jerry Brown, who spent his first year specializing in cuts to students and the disabled while expressing no overt support for public reinvestment, apparently thinking he could use additional state budget cuts to scare legislators into voting a tax increase measure onto the ballot. Legislators have no reason to care about cuts (Republicans have pledged to make cuts, and Dems, as I'm arguing, are too conflicted to know why cuts are fatal).  Brown's strategy failed with the legislature, but lacking a vision of social development, he now plans to use the same fear tactics on the public, to be coupled with the psuedo-sweetener of proposed cuts to public pensions.  He will probably fail with tax increases, and probably succeed with the pension cuts.

Lacking a theory of broad public investment, Democrats punt to the same faulty theory of private investment as do the Republicans.  This means accepting the orthodox and, indeed, formerly right-wing claim that if government stops interfering with capital markets, they will allocate capital with maximum efficiency, allowing the general welfare the fastest possible advance. This idea makes legions of Democrats into Eisenhower Republicans, as they join Republicans in putting budget cuts ahead of schools and highways and bullet trains and all the other "build America" programs that would still get them elected. In this view, society doesn't need to plan independently of its business interests, nor, through its elected officials, set its own priorities and tax itself to support its goals.  Venture capitalists and advanced firms can take care of all meaningful investment in technology once the early, high-risk stage has been completed. To help private capital, in this view, the best things government can do are (a) pony up early-stage funding to qualified high-tech parties, no strings attached, and (b) keep taxes low on investors, e.g. let them redefine their income as carried interest and tax it at only 15%.

The university boom rested on an older vision of general development as an explicit alternative to elite development: a society would be smarter and also richer if you spread knowledge broadly rather than showering all of the best on the heads of the Ivy League few.  The swan song of this Democrat-style vision was the Full Employment and Balanced Growth Act of 1978 ("Humphrey Hawkins"), which instructed the government to intervene in markets and override or coordinate private firm decision-making for the sake of making the broadest use of the workforce.

In the 1990s, the university became part of a "new economy" that assumed wealth maximization meant unequal concentration of resources in the best financial and technical people.  Keynes was replaced by Schumpeter, and the university's research and clinical activities overshadowed instruction and public service even when the latter was instrumentalized as "human capital formation."  In a Regents meeting last year, Berkeley chancellor Robert Birgeneau remarked that Silicon Valley gives to private universities like Stanford, but has done very little for the University of California.  Their position fits with the consensus logic: for private industry, government should be big enough to offer free R&D funding at the early high-risk stage, but small enough to take no piece of the financial action later on.

We can put the current consensus another way: government funding should go directly to the relatively small elites who will make the best use of it, and not be spread broadly around the population, most of whom will make little use of it.  Funds should be targeted carefully to go directly to the enterprise system through programs such as that for Small Business Innovation Research program (SBIR).  This is far different, in the current Democratic view, from "entitlements" in their much larger amounts.  Targeted tech investment is thought to create wealth and knowledge while general investment in human capability, which is one way to think of education and Medicare and Social Security, seems in this view to be  maintenance at best.  Put another way, tech investment forms a foundation for private capital, while entitlement spending supports maintenance-oriented consumption.  Hence many Democrats, from Erskine Bowles to Barack Obama, are looking for politically-viable ways to cut "entitlements."

We are trapped in a Republocrat consensus view that public investment  is maintenance or waste, while private investment builds the infrastructure and new industries that we need for the future. The exception is the small portion of public funding that goes directly into the system of private capital. Over the past thirty years, university research has remade itself so as to appear as part of a private future-value chain. The logic of this model of small-public to enable large-private investment is that universites can survive on much less public money: the latter can be targeted to high-value activities like biotech or nanotech research, while lower-value activities for the masses, like undergraduate education or non-technological research, can be paid for on a discretionary basis by tuition.

In the UK, the Browne Report and Cameron government White Paper make the supremacy of private investment explicit, and one result is the coming elimination of the government support for teaching the arts and humanities in British universities.  In the UK and US alike, the alleged necessity of subordinating public to private investment enables the complacency towards public funding cuts that we see in Jerry Brown and many other Democrats, including well placed leaders of higher education.

In the US, the skew towards private control of the economy is a deep cultural bias, and difficult even to address.

II. Market Failure

And yet we must address it. Unfortunately, the idea that private capital produces general investment is false.  One way into the issue is the well-studied phenonemon of "market failure" -- markets fail to allocate resources efficiently in various senses, and they systematically underinvest in the creation of knowledge.  Mainstream research on the topic goes back at least to the 1950s (e.g. Kenneth Arrow's influential 1959 piece).  A key idea is that firms do not spend money on research or development where future returns cannot be calculated, as is the case with all early-stage research, or the benefit to the firm will be small (even if the likely social benefits are very large.)  Conservative economists like Milton Friedman did not deny market failure, but countered it with the claim of government failure, thus creating a stalemate with the market failure crew that became a clear policy advantage during the Reagan presidency. The result is that for decades our industrial policy has consisted of giving public money as directly as possible to the private sector, very early in the development process, and of nothing else.

Education is a massive  bulwark against market failure in the sense that it makes invention and advancement possible everywhere in society.  But the kind of broad social development that education supports is exactly what within tech-based finance capitailsm is threatening to the business model.

Debates aside, we can chart the outcome of our private-uber-public model:  an investment decline that began before the crisis, around 2005, and that falls as readily as it rises during periods of declining marginal tax rates:

The Atlantic magazine has a chart telling the same story about job creation.  Not surprisingly, it turns turns out that rich people don't use their piled higher tax savings to create jobs.

The least we can say is that there is no obvious effectiveness in shifting capital allocation from public to private processes.  To the contrary, there's a correlation between the public control of funds through the tax process and ordinary measures of economic well-being.
III. Confronting Subsidy Capitalism

The irony of this bias against seeing the social value of public funding is that it reduces public funding to the status of a subsidy for the private sector.

One obvious example is the mind-boggling public support for the banking sector: CNN Money pegged it at $3 trillion by November 2009, and two years later estimates for a whole slew of non-transparent programs range from $7.7 trillion (Bloomberg) to $16 trillion (cumulative total from the GAO, same source) to an unbelievable $29 trillion.   The public subsidy structure appears in various ways, including free profits gained when a bank borrows from the Fed at 0.01% interest and loans it out at 4-5% 

Though the context, motives, outcomes and so on are different in banks and universities, the private disposal of public funding is similar. We could offer a range of examples from the university system, but I'll stick with just one, federally-funded research.  If we look at the National Science Foundation's 2010 Science and Engineering Indicators for 2010, we find a chart (Figure 4-9) showing how federal R&D funding is divided up --to  industry, universities, and so on.

Universities have increased their share of federal R&D expenditures by a factor of 4 since the mid-1960s.  And yet the largest portion of public R&D spending continues to go to private industry, which uses about 80% of that money for "develoipment" rather than research (Figure 4-5) 

Subsidy capitalism means that the public, directly or indirectly, does not participate in the investment, research, and development decisions that remake society year in and year out. It hands over resources and all decision rights at the same time. A recent study by UC Davis researchers Fred Block and Matt Keller shows that high-value research is decreasingly done by large private firms and is increasingly funded by government, and yet such research receives a minority of public funds, which flow mostly to the corporate sector.  Lacking direct voice over R&D directions, American society loses the capacity for public coordination or even to express common aims, and in compensation we exaggerate the genius of individual private sector leaders like the late Steve Jobs at Apple.

Public funding is not given credit for intelligence and foresight, and has become in our culture of captialism dumb money, an early-stage investor without management control.  There is a profound cultural limitation at work here: American leaders see the agencies responsible for social benefits as categorically less insightful than the financially self-interested private sector, even though the latter are focused entirely on their own advantage.  As it is now, the future emerges in erratic bursts from the secret development operations at companies like Google (e.g. this radio report on the sudden appearance over Silicon Valley of The Cloud).  We are having an increasingly difficult time imagining a collective future that emerges from common activity.

In this context, it makes sense that even direct donors to the university, about 98% of the time (at UC), restrict their donations so that their money will not flow into the general operating funds that support the generic educational activities of large masses of students. The latter, which has the greatest impact on the wealth and understanding of society, achieved its lofty post-war level of quality entirely through tax-based general funds. 

These public funds are exactly what are being withdrawn -- California is a national leader here (see for example this cuts post from Februrary 2009).   State and federal tax avoidance remains a central revenue strategy for American corporations. In California, business's share of state revenues is about half of what it was in 1981 (slide 36).  The effect on education has been dramatic: California hasn't simply traded in its top-10 advantage for mediocrity.  In many measures of expenditures in K-12, it is in a race for last.

Public universities can help build a better and more equitable economy if they start showing systematically that public investment needs now to take precedence over private.  If they don't, 2012 will be the first of many reruns of 2011, only worse.


Catherine Liu said...

Thanks Chris. Brilliant post. Should be required reading.

Anant Sahai said...

I think that there is one related point that I think should be mentioned: the role of pervasive financial derivatives in changing the financial culture. The problem is that a financier can make money when the economy grows *and* when the economy falls. The great mass of people only benefit when things get better. But the "popular" understanding of finance theory can't see this difference. Let's call this the "Let them eat puts" effect.

To see this, pretend that you are a financier. You foresee that the housing market is heading off a cliff, and is likely to drag down the entire economy with it. Because of financial derivatives, you can use this knowledge to profit greatly. To fully exploit this opportunity, you will try to hide this knowledge and trade surreptitiously with "suckers" (e.g. a pension fund) until you have accumulated the position you want. At this point, you will try to bring down the housing market and/or otherwise collapse the economy so your portfolio appreciates. Both of these (promoting ignorance and trying to blow things up) are antisocial.

What would you have done in a world without derivatives? You're a rich person so you have tremendous exposure to the real economy. To save your own interests, you would try your best to stabilize the economy. To do that, you would have to coordinate with your fellow citizens through the government. Public investments pay off for you too. The only way to reduce your risk is to reduce the risk for everyone.

So with an ample supply of financial derivatives, many powerful people believe that they can privately control their own risk by trading as opposed to the traditional way --- by getting together with everyone else because we're all in the same boat. Combine that with private schools, private jets, private security guards, etc..., and you see a serious lack of commitment.

Growing up, I had always considered the corporate tax rate as the American People's equity share in private enterprise. It represents a kind of preferred stock, but without any voting power. It seems to me that in today's financialized world, something like this should be made explicit to prevent companies from using tricks like stock buybacks, acquisitions, etc... to avoid paying Uncle Sam. If the shareholders are getting paid, so should We the People. But it is hard to see how this philosophy could extend to derivatives because of their zero-sum nature.

Bob Samuels said...

I have been thinking about writing something on the Speculation Culture, which directly relates to the comment above. Currently, corporations are sitting on a record-breaking trillion dollars on their balance sheets. Meanwhile, many corporations have shown record profits, while economic growth is near zero. How is this possible?

One thing is that wages are being squeezed and benefits are being cut, which increases the profit margin. Meanwhile companies are buying back their own stocks and giving themselves bonuses. Also, banks are getting money at near zero interest rate and lending it out at a much higher rate. This process is similar to the UC's deal to lend the state $1.7 billion, which is an arbitrage based on UC's high bond rating and low interest rates.

In the speculative economy, we have become detached from any real economic production, and one is betting on other people's bets. In fact, members of Congress bet against the US economy after they met with the Fed. The biggest threat in this system is that gains are privatized and losses are socialized. Thus, Germany does not want its banks to lose big on their Greek bonds, so it is forcing Greece to sell off its public institutions and gut pensions and social welfare.

As I have written in the past, universities are now being forced to take on neoliberal austerity measures in order to lower their interest rates. UC has been told that it has a lot more debt capacity, so it should borrow more, build more, but it should also stops its dependency on unreliable state funds and try to reduce benefits and cut labor costs by fighting unionization.

In turn, the UCs long-term plan for constant tuition increase not only pleases the bond raters, but it tells the state that it can handle more budget cuts. The state and UCOP still think the UC is under-priced and student debt is manageable through a high-fee, high aid model.

Even if new taxes are passed in Cali, the UC is so far down the path of financialization and privatization that it cannot reverse course. Depressingly, as the UC increases its reliance on undergrad tuition, it short-changes undergraduate budgets. We need to tie the defense of affordable public higher education to the defense of quality instruction and research.

Unknown said...

Tuition has doubled under the leadership of UC Berkeley Chancellor Birgeneau.

Oust Chancellor Birgeneau and his $450,000 salary.

Unknown said...

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